Focus: Distressed debt M&A – share transfers without a scheme
17 February 2015
In brief: The Supreme Court of New South Wales has given further guidance on the scope of its power to grant leave to a deed administrator to compulsorily transfer the shares of a company. The decision, in the matter of Nexus Energy Ltd (subject to deed of company arrangement)  NSWSC 1910, confirms that this can be done where the transfer does not 'unfairly prejudice' shareholders. This case involved the novel context of an insolvent ASX-listed parent company with solvent operating subsidiaries. Partner Kim Reid (view CV) and Associate Thomas Bagley report.
How does it affect you?
- Bidders might wish to acquire the shares of an insolvent company and access the valuable interests in that company's operating subsidiaries.
- To achieve this, a deed of company arrangement (DOCA) can provide that a condition precedent to the injection of funds is court approval under section 444GA of the Corporations Act 2001 (Cth) for the shares of the parent company to be transferred to the person proposing the recapitalisation.
- The court's decision reinforces the effectiveness of DOCAs as a tool to extract value for a company's creditors and to restructure its share capital.
- The practical advantages of this process may depend on the ability of the deed administrators to address a range of evidentiary challenges and other factors and obtain court approval in a timely manner.
- Where those matters weigh against the benefits of acquiring the shares, a bidder can consider whether it can side-step this process by acquiring the subsidiaries or their assets directly, rather than by purchasing shares in the parent company.
The Nexus group comprises ASX-listed Nexus Energy Ltd and several wholly owned subsidiaries, including:
- one with an interest in the Longtom gas and condensate resource in the Gippsland basin off the coast of Victoria; and
- another with a stake in the Crux resource in the Browse basin off the north-west coast of Western Australia.
From at least 2013, the Nexus Group was in financial distress. Its 2013 accounts recorded a net deficiency of current assets of approximately $47 million. In February 2014, the Seven Group made a conditional proposal to acquire Nexus' shares at 5¢ a share. The Nexus board also made efforts to explore refinancing and other alternatives. The following then occurred:
- A proposal for a scheme of arrangement between Nexus and SGH2 (the bid vehicle associated with Seven) was announced in March 2014. SGH2 proposed to acquire the shares in Nexus for 2¢ per share.
- SGH2 also bought about two-thirds of the subordinated loan notes issued by Nexus. NIH (also associated with Seven) replaced Nexus' senior lenders and took security over Nexus' assets, including its subsidiaries. NIH also provided a bridge facility to one of the subsidiaries.
- The proposed scheme of arrangement was rejected at a scheme meeting held in June 2014.
- NIH accelerated the repayment under the bridge facility so that the secured monies under the senior debt facility (approximately $165 million) became due and payable by Nexus.
- Voluntary administrators were appointed to Nexus. Although the bridge facility was cancelled and the trustee for the noteholders declared an event of default, NIH funded the voluntary administrators under a court-sanctioned loan.
- The voluntary administrators sought proposals in respect of Nexus, its subsidiaries and their respective assets.
- SGH2 proposed a DOCA. It was the only bid received by the voluntary administrators and the DOCA was approved by the creditors and executed in August 2014.
- Its key terms included a requirement for SGH2 to pay all secured and priority creditors' claims in full, and to provide unsecured creditors with approximately 75c in the dollar. The DOCA also required the deed administrators (previously the voluntary administrators) to seek to transfer all ordinary shares in Nexus to SGH2 without any consideration payable to shareholders.
The approval application
The deed administrators sought an order under s444GA, granting them leave to compulsorily transfer Nexus' shares to SGH2. The court application was supported by the Seven Group and various creditors, while a core group of shareholders attempted to oppose the grant of leave.
Section 444GA provides that a deed administrator may transfer shares in a company with the consent of the owner of the shares or leave of the court. The court may grant leave only if it is satisfied that the transfer 'would not unfairly prejudice the interests of the members of the company'.
The NSW Supreme Court granted leave under s444GA. It reiterated the key statements of principle that:
- the law gives deed administrators the ability to compulsorily sell company shares for the purpose of implementing a DOCA, where payment to creditors depends on the share transfer occurring;
- the notion of unfairness only arises if prejudice is established;
- whether a transfer of shares is unfairly prejudicial to shareholders depends on the value of their shares in a (hypothetical) liquidation scenario. As the court had previously held in Mirabela Nickel,1 that test applies if a winding up is the likely or necessary consequence of the transfer of shares not being approved; and
- members do not suffer any prejudice if the shares have no value, the company has no residual value to members and if the members would be unlikely to receive a distribution in a winding up.
The deed administrators said that the proposed transfer was not unfairly prejudicial to shareholders because:
- they would not obtain a better return for their shares in a liquidation of Nexus rather than under the DOCA; and
- the company's creditors would achieve a worse result under a liquidation than the DOCA.
Both the deed administrators and shareholders led expert evidence to compare the position of shareholders if the transfer did not occur, as against their position if the transfer occurred.
The expert evidence considered two scenarios, one being a valuation of Nexus as a going concern and the other being a valuation of Nexus in an insolvency. The court rejected the shareholders' contentions that a going concern valuation was relevant, given the clear evidence of Nexus' immediate financial distress.
The court preferred the expert evidence put forward by the deed administrators. On that basis, the shares had no residual value, and the court was satisfied that the transfer would not unfairly prejudice the interests of shareholders.2
The decision builds on the earlier decision in Mirabel Nickel by providing guidance in relation to:
- the onus of proof that deed administrators must meet in seeking leave, and shareholders must meet in demonstrating unfair prejudice;
- the operation of the Mirabela Nickel principles in the context of an insolvent company with solvent operating subsidiaries; and
- the effect of alleged deficiencies in the sales process on the exercise of the court's discretion.
It shows that, although the court has an important role to play in safeguarding the procedural and substantive interests of shareholders, shareholders may face practical difficulties in resisting applications made by deed administrators in certain circumstances.
The parties accepted that:
- the deed administrators had the legal onus of proving that the discretion to allow the transfer of shares should be exercised in their favour; and
- the shareholders had an evidentiary onus to establish the alleged prejudice.
A key issue was whether the deed administrators were required to meet a legal onus at a heightened civil standard.3 The court rejected the shareholders' submissions that s444GA(3) was extraordinary and that Parliament did not intend for the disposal of shares without adequate compensation. It refused to apply this heightened standard to the deed administrators' application. Instead, it held that 'unfair prejudice' needs to be considered in the context of the purposes of Part 5.3A of the Corporations Act (which is focused on maximising returns for creditors) rather than with a single-minded focus on the interests of shareholders.
The question of 'unfair prejudice' was complicated by the fact that a winding up of Nexus would not necessarily have that consequence for its two key operating subsidiaries. None of the previous cases to consider s444GA involved a situation like Nexus where:
- the holding company was subject to a DOCA but the operating subsidiaries were operating under financing arrangements that preserved their solvency; and
- a possible outcome of a liquidation was that the parent (rather than its operating subsidiaries) would be placed into liquidation, with the prospect that a receiver could be appointed to the subsidiaries by a secured creditor exercising its security rights.
In this case, Nexus and its subsidiaries had avoided insolvency by the terms of the funding deal between NIH and the deed administrators. Given the level of Nexus' debt and current assets, the court held that it was almost inevitable that Nexus would go into liquidation at a further meeting of creditors if the DOCA had failed. Although it did not follow that the operating subsidiaries would go into liquidation, the evidence showed that:
- if Nexus were to be wound up, this would be an event of default under the funding agreement between NIH and Nexus;
- it was more likely than not that NIH would then appoint a receiver of the secured assets of Nexus; and
- the receiver would likely attempt to sell the shares in the subsidiary companies and (if Seven made an offer for the shares) execute the sale.
Accordingly, while the parties' valuation evidence was directed to a liquidation of the operating subsidiaries, the court noted that the value of Nexus' assets could alternatively be valued by reference to a receivership sale of the operating subsidiaries' assets. However, the evidence did not disclose any difference between those outcomes on the facts of the case.
Integrity of the sales process
A complaint made by the shareholders related to the relationship between Nexus and Seven (including the presence on the Nexus board of the managing director and chief executive officer of an entity within the Seven Group and Seven's position as a third-party lender) and the alleged impact that relationship had on the integrity of the sales process.
The court accepted that, in some cases, the influence of a secured creditor over the sales process, including the time available, might lead a court to conclude that it should decline to approve a transfer of shares under s444GA in the exercise of its discretion. However, the court found that the sales process here was not tainted by Seven's influence because it was commenced:
- before the deed administrators had been appointed; and
- under the control of the Nexus board and with the involvement of external advisers.
The court also rejected a number of allegations made by the shareholders, particularly the assertion that NIH 'caused Nexus to become insolvent'. It held that there was no evidence to support this allegation. Nexus had been likely to become insolvent for a considerable period of time because of its substantial financial commitments in relation to Longtom and Crux, and the fact that its only income (from Longtom) had been disrupted by disputes and other difficulties.
While the immediate cause of Nexus' insolvency was NIH's actions following the failure of the scheme of arrangement, there was no reason to assume that any lender would have provided ongoing support for an indeterminate period in the absence of a demonstrated ability to pay debts.
The decision is a reminder that, while care should be taken to ensure that any sales process is appropriate, time constraints imposed by limited funding arrangements are relevant to the grant of leave for the transfer of shares under s444GA.
- Re Mirabela Nickel Ltd (subject to Deed of Company Arrangement)  NSWSC 836.
- The shareholders informed the court that they proposed to appeal the decision. They sought, but were not granted, a stay of execution of the judgment or orders restraining the deed administrators from acting in accordance with it: Re Nexus Energy Ltd (subject to DOCA)  NSWSC 1914.
- As to which see Re Mirabella Nickel Ltd (subject to DOCA)  NSWSC 836 at  (referring to Briginshaw v Briginshaw (1938) 60 CLR 336).
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